IBM Shrinks - Analysts Hate It

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 |  About: International Business Machines Corporation (IBM)
by: Rizzi Capital

IBM (NYSE:IBM) reported earnings on October 16th, and the news was not exactly what analysts and investors were expecting. The company showed a marked slowdown in sales and profits misses estimates. The shares had already been on a pronounced downward trajectory since hitting an all time high on March 15th, and the weak earnings report did nothing to change the stocks direction. The shares fell hard after the earnings report and subsequently rebounded into November. But since last week, IBM's stock has resumed its downward movement.

Stock Sliding

IBM is currently trading down about 15% from its peak in early 2013. In a market which seems to be hitting new all time highs every day, this is certainly not good for shareholders. While the S&P has powered higher by 26% so far this year and the Dow Jones has increased by over 22%, IBM has actually lost over 6%.

IBM is actually the second most highly weighted stock in the Dow 30, following closely behind Visa (NYSE:V). Its extremely poor performance this year, the worst among all 30 Dow stocks has actually been the leading cause for the index trailing behind the S&P's performance. Had it not been for IBM's drag, the Dow would be considerably higher.

For shareholders, IBM's quarterly dividend of 95 cents per share, currently yielding about 2% per year, has been some consolation. Moreover, IBM shares have increased over 100% since bottoming out in late 2008. For a company of it's massive size, it's a pretty remarkable performance. While multiple expansion has been a leading cause of the company's rise, the massive stock buyback plan has also been a driving force behind increasing earnings per share. In the last 4 years, IBM has repurchased and cancelled over 200 million shares, representing about 15% of the company. And since 1996, IBM has retired almost 1 billion shares, representing a massive 50% of all common outstanding shares. The chart below shows IBM's shrinking share count.

Saved By The Buyback?

In October, the company announced it was increasing its buyback plan by a further $15 billion. The repurchase program now has a total of $20.6 billion. With a lack of growth prospects going forward, reflected in the company's six consecutive quarters of shrinking revenue, the company is clearly using the repurchase program to drive earnings per share. CEO Ginni Rometty has a goal of increasing EPS to $20 by 2015, from $15.25 last year. The massive buyback will be the main tool used to enable that growth.

"This is one of the biggest tools they have to increase earnings per share if their growth rate is flat. If they're not growing, they can reduce their share count." Ivan Feinseth, CIO, Tigress Financial Partners

IBM is using a form for financial engineering to drive earnings per share higher. While there is nothing particularly wrong with that, shareholders should examine the company closely before making an investment decision. On a superficial level, IBM looks like it is a healthy, growing company. And despite it's share price being off its all time high, the stock is still trading close to its peak. A long term look at the company's historic revenue shows a vivid image of anemic growth. The chart below shows IBM's yearly revenue data going back to 1996.

Analysts Notice The Shrinking Revenue

Adjusted for inflation, IBM's revenue of $76 billion in 1996 would equal about $113 billion today. In reality, IBM is projected to have revenue of only about $100 billion in 2013. Fundamentally, IBM has been a shrinking company for the last 18 years. Going forward, while earnings per share will continue to increase as the company throws billions of dollars at its buyback program, if there is no clear strategy for reinvigorating growth, IBM will be in a lot of trouble. The company's declining share price of late, despite managements clear objective of increasing earnings per share by almost $5 by 2015, could be a signal that investors are becoming skittish about the continued revenue decline. It's definitely something that I think all investors should consider.

I think it is also usually beneficial to examine what analysts have to say about IBM as they often set the tone for investors expectations. Since the company's latest earnings announcement, analysts have come out with a rash of downgrades on the company. In light of this, I would venture to presume that, had IBM not had such a massive buyback program in place, its share price would have suffered far more than it currently has.

The following chart summarizes the latest analyst price target changes on IBM's shares. To read the report issued by each analyst, simply click on the analyst's firm link.

Date

Firm

Action

Rating

Old Target

New Price Target

Oct 17, 2013

UBS

Downgrade

Neutral

$235

$186

Oct 17, 2013

RBC

Price Lowered

Sect. Perf

$205

$195

Oct 17, 2013

Goldman

Price Lowered

Hold

 

$175

Oct 17, 2013

Deutsche Bank

Price Lowered

Buy

$225

$200

Oct 17, 2013

BMO

Reiterated

Hold

 

$215

Oct 17, 2013

Barclays

Price Lowered

Equal Weight

$190.00

$180.00

Oct 17, 2013

Credit Suisse

Price Lowered

Underperform

$175.00

$160.00

Oct 17, 2013

Evercore

Price Lowered

Overweight

$235.00

$210.00

Oct 17, 2013

Jefferies

Price Lowered

Hold

$210.00

$190.00

Oct 17, 2013

JPMorgan

Price Lowered

Neutral

$196.00

$179.00

Oct 17, 2013

Societe Generale

Price Lowered

Hold

$193.00

$187.00

Oct 17, 2013

Credit Agricole

Price Lowered

Outperform

$225.00

$215.00

Oct 23, 2013

Zacks

Reiterated

Neutral

 

$184.00

Click to enlarge

It seems that IBM's earnings upset in October was a real turning point for the company, as analysts were forced to throw in the towel and dramatically reduce their share price expectations. While analysts had previously issued many share price reductions in July, when IBM announced some poor results, the price reductions were generally only marginal. The latest batch of price cuts were much more severe. And it is important to note that IBM's shares, currently trading at about $180, are currently trading below most of the analyst targets indicated above. Considering the company's weak performance of late and the fact that revenue is expected to continue declining, there is a high probability that analysts will further reduce their share price expectations next quarter.

Conclusion

IBM seems to have lost its way recently. While the share price is not very reflective of this, the underlying performance of the business is showing signs of decay. Growth in the company has been lagging behind inflation for the last 18 years. The company has experience 6 consecutive quarters of declining revenue. Had it not been for the massive share buyback forcing earnings per share higher even as the company shrinks, IBM's share price would be dramatically lower today. Analysts now seem to be noticing the cracks in "Big Blue's" armor and have issued a string of share price reductions since the last quarterly report. Investors should be cautious going forward. Considering the share price gains that have been made over the last 3 years, now may be time to take some profit off the table.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.